No-action clauses continue to receive considerable attention as a result of litigation arising from the 2008 financial crisis. For example, decisions in Quadrant Structured Products Co. v. Vertin, 23 N.Y.3d 549 (2014) (holding that since the no-action clause did not mention suits relating to the securities, it did not preclude suits based on the securityholders’ independent common law or statutory rights under the notes) and Akanthos Capital Mgmt., LLC v. CompuCredit Holdings Corp., 677 F.3d 1286 (11th Cir. 2012) (holding that the no-action clause barred fraudulent transfer claims arising under state law) demonstrate the intricacies of applying a relatively simply provision present in virtually all indentures. A recent case in the Southern District of New York, Daniel Penades v. The Republic of Ecuador, 2016 WL 5793412 (S.D.N.Y. October 2016), provides a cautionary tale of the perilous results of an idiosyncratically drafted no-action clause.

Background

Ecuador’s complicated relationship with the bond market began in 2006 with the election of Rafael Correa, who had campaigned on a platform of debt repudiation. By December 2008, Correa had publicly declared his intention to no longer pay interest on approximately $4 billion of bonds, including its 2030 global bonds. Rather than engage in a formal restructuring, Ecuador purchased much of the outstanding debt in the open market for approximately 35 cents on the dollar. Holders who declined to sell their bonds to Ecuador were left without interest payments. One such holder, Daniel Penades, commenced a claim to recover interest due under his holdings of 2030 bonds.

he Court’s Analysis

In Penades, the plaintiff sought, among other things, recovery of unpaid interest for Ecuador’s failure to pay interest when due under the 2030 bonds. Importantly, the 2030 bonds were not registered under the Securities Act of 1933, and the indenture was not qualified under the Trust Indenture Act of 1939. Thus, to bring a claim, the plaintiff had to overcome a seemingly standard no-action clause set forth in Section 4.5 of the indenture, without the benefit of Section 316(b) of the TIA, which provides a statutory right of each holder to commence an action for recovery of payments of principal and interest, notwithstanding any provision in an indenture that could be interpreted to the contrary.

At the outset, the court noted that “no-action clauses” are “strictly construed” but “regularly enforced … to preclude state law claims.” The no-action clause in the Ecuadorian bond indenture was extremely broad, “applying to ‘any suit, action or proceeding’ brought ‘upon or under or with respect to the Indenture or the Bonds.’” Thus, the court held that the no-action clause applied to the plaintiff’s action, and that the plaintiff by his own admission failed to comply with the requirements of the no-action clause, to wit, bondholders representing not less than 25% of the principal amount of the 2030 bonds delivering a request to the trustee to commence suit for the nonpayment of interest and failure by the trustee to bring such a suit within 60 days.

Next, the court analyzed the principal exception to the no-action clause. Unlike a typical indenture, Section 4.6 provided that bondholders have the “unconditional right … to receive principal and interest at maturity” (emphasis added). Although the indenture did not define “maturity,” the court interpreted the term to mean the last date on which the debt obligation was due. This interpretation comported with the other usages of the term “maturity” in the indenture. Based on this analysis, the court held that the no-action clause precluded individual suit to recover defaulted interest, which was required to be paid regularly throughout the life of the bonds, until the bonds’ maturity on Aug. 15, 2030.

Observations

The no-action clause in the Ecuadorian bond indenture was atypical, and did not follow the standard formulation drawn from Section 316(b) of TIA. Under the standard formulation, there is an exception to the demand requirements of a no-action clause for suit to recover payment of principal and interest “when due,” and not “at maturity.” The Ecuadorian bond indenture was not qualified under the TIA, and therefore did not incorporate Section 316(b), which would have trumped the more restrictive language that actually appeared in the indenture.

The district court’s holding in Penades is somewhat surprising, as there is no more fundamental right of the holder of a debt instrument than to receive payment when due. That the court felt constrained to interpret the no-action clause here with brutal literalness serves as yet another reminder that debtholders should pay careful attention to the particular nuances of the no-action clauses in their indentures.